Main macro themes

The European gas situation remains fragile although an immediate European gas crisis has been averted. European gas prices surged to new highs, as Russia cut supply further, despite the re-opening of North Stream 1 after the maintenance period, The EU Commission unveiled a new plan to cut EU gas consumption by 15% until next spring, which received a lukewarm reception from EU countries. Meanwhile, Italy has been plunged into a new government crisis and early elections will be held on 25 September (read more in Flash comment - Italy is falling back into old habits, 20 July).

Concerns about the global growth outlook have intensified. Despite the postlockdown rebound, Chinese Q2 GDP growth surprised on the downside at 2.6% q/q, while the rising property stress remains a key headwind (see China Macro Monitor, 18 July). PMIs brought more evidence that economic momentum is slowing, as tighter financial conditions and persistently high inflation are weighing on demand, bringing the euro area to the brink of recession (see also Research Germany – Zeitenwende, 25 July). The US is in technical recession, as GDP fell in both Q1 and Q2, but the strong July Jobs report as well as ISM Services index suggest that the underlying growth is still relatively strong. Employment gains were broad-based across sectors, and the tight labour market conditions continue to put upward pressure on wages, rising the probability of another 75 basis point Fed hike in September.

Central banks are increasingly frontloading monetary policy tightening. ECB surprised with a 50bp rate hike, while also complementing its normalisation process with a new Transmission Protection Instrument (TPI) to limit unwarranted spread widening (see also ECB Review, 21 July). As expected, the Fed hiked the target range by 75bp to 2.25-2.50% and policy is now back to neutral. Bank of England also hiked rates by 50bp for the first time since 1995 despite now expecting UK economy falling into a recession in Q4. With inflation pressures still strong and broad-based, we continue to see risks tilted towards more front-loading of rate hikes, see Fed Research – Review: Front-loading to continue despite growth risks, 27 July.

Market developments

Risk sentiment remains fragile amid recession fears, although moderating inflation and rate hike expectations have supported equity markets over the past weeks. Italian bonds have come under pressure following the government crisis and lingering market doubts about the effectiveness of ECB’s TPI.

USD has continued to strengthen on a broad basis with EUR/USD falling briefly below parity on 14 July. We expect a further drop in the cross to 0.95 over the next year, as the euro area continues to suffer from a negative terms of trade shock and EUR/USD is overvalued vs fair value.

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